Unit 1 Introduction to Corporate Governance Unit 2 Theory of the Firm Unit 3 Corporate Governance and the Role of Law Unit 4 Corporate Governance Around the World Unit 5 Board Composition and Control Unit 6 CEO Compensation Unit 7 International Governance Unit 8 Overview of Corporate Governance Codes

1. Corporate Governance
By Dr Ola Brown

2. Contents
Unit 1 Introduction to Corporate Governance
Unit 2 Theory of the Firm
Unit 3 Corporate Governance and the Role of Law
Unit 4 Corporate Governance Around the World
Unit 5 Board Composition and Control
Unit 6 CEO Compensation
Unit 7 International Governance
Unit 8 Overview of Corporate Governance Codes

3. Unit 1
Introduction
to Corporate
Governance

4. Corporate governance refers to ‘the ways suppliers of
finance to corporations assure themselves of getting
return on their investment’
-Shleifer and Vishny, 1997
Corporate Governance is concerned with the systems of
laws, regulations, and practices which will promote
enterprise, ensure accountability and trigger
performance.
-World Council for Corporate Governance

5. Corporate governance deals with the rights and
responsibilities of a company’s management, its board,
shareholders and various stakeholders. How well
companies are run affects market confidence as well as
company performance.
Good corporate governance is therefore essential for
companies that want access to capital and for countries
that want to stimulate private sector investment. If
companies are well run, they will prosper. This, in turn,
will enable them to attract investors whose support can
help to finance faster growth.
Poor corporate governance, on the other hand, weakens a
company’s potential and, at worst, can pave the way for
financial difficulties and even fraud
-McGill and Patel (2008)

6. Approaches to corporate
governance
There are two main traditional approaches to the study of corporate governance: institutional
and functional. I call them the wide lens vs the narrow lens approach. Or the conservative vs
liberal approach.
• An institutional approach to corporate governance involves examining the existing
institutions to see how they can produce the services they offer more efficiently. In
corporate governance, institutions generally refer to the regulatory, legal and financial
framework that underpins the governance system. An institutional approach would
therefore look at each of these areas and see how they could be improved upon in order to
improve governance generally. More recently, there has been increasing focus on legal
institutions to see how they can be strengthened to protect investors against corporate
fraud.
• A functional approach looks at how different institutional arrangements can function in
different ways. This type of approach takes the view that there are different ways to address
similar governance concerns. It implies a more open-minded approach to examining
different possibilities. The core function is to facilitate investment. However, there are many
different ways by which investment can be facilitated.

7. Increased globalisation with complex
networks of international financing
arrangements has deepened the gap between
shareholders and management
Two major systems of corporate governance
i. Dispersed: typical of the UK & US.
Dispersed ownership and with strong
shareholder protection.
ii. Concentrated: typical of many
European countries. Concentrated
shareholding leading to weaker
protection.

8. The concept of
ownership
• We have seen in earlier studies that Jacob’s first
son, Reuben, sinned with his father’s concubine
Thus, his birthright was divided between his
brothers Judah and Joseph.
-Gen. 35:22

9. Car vs Corporation
• Simple when applied to a car, a goat or a
house.
• But more complex when a shareholder
owns a fractional share of a corporation.
Basically an intangible interest, in an
intagiable asset. The company itself has
assets, buildings, trucks, people. But its
not like you have one of the tyres of truck
in your safe at home.
• The only certain thing is the power to
transfer.

10. The purchaser of stock considers that
he is acquiring an interest in an
enterprise , not so much that he is
assuming common relations with
numerous other stockholders, for the
most part he doesn’t know them and
does not take the pains to know who
they are. If he ‘knows the property’
and directors, he is happy.
This has led to a disappearance of
the ownership in any meaningful
sense of the word. Like the Cheshire
cat.

11. The directors of such [joint-stock] companies, however,
being the managers of other people’s money than their
own, it cannot well be expected, that they should watch
over it with the same anxious vigilance with which the
partners in a private co-partnery frequently watch over
their own.
Like the stewards of rich men, they are apt to consider
attention to small matters as not for their master’s
honour, and very easily give themselves a dispensation
from having it. Negligence and profusion, therefore,
must always prevail, more or less, in the management of
the affairs of such a company.
Source: Adam Smith (1776)

12. Just a quick note about private equity and ownership
• Often seen as wicked people
• Mitt Romney, ‘kills jobs’
If you examine all the major corporate
scandals of the past 25 years, none of
them have occurred where a private
equity firm was involved. Businesses have
failed, but not due to corruption. I
believe that as genuine partners we are
vigilant in our role as owners and we
protect shareholder value
-Henry Kravis, The private equity
conference, New York, 2004

13. Ownership and control
• It often seems like it was scandals like Enron that made people concerned
about corporate governance, but actually it has been of concern since the
formation of the joint stock company.
• Discussions, frustrations and research focus on a single key concept: the
separation of ownership and control.
• The way modern corporations have evolved produced a situation such that
the interests of owners and managers have diverged-Berle & Means
• The separation of ownership and control was effectively a separation of
decision-making and risk-bearing functions, allowing organisations to
benefit from specialising in management and risk bearing. Separating
ownership and control also meant new expenses for the firm. These are the
monitoring costs associated with aligning the interests of owners and
managers. Much of the study of corporate governance is concerned with
how to curtail these costs and improve alignment of the interests between
owners and managers.

14. What is a corporation?
‘A mechanism established to allow different parties to
contribute capital, expertise, and labour, for the
maximum benefit of all of them.’
-Monks and Minow
Essential characteristics of the corporation:
i. Limited liability
ii. Transferability of investor interests
iii. Legal personality
iv. Centralised management.

15. The Middle Ages
• In the Middle Ages, corporations were
more like municipalities than business.
• They included towns, universities and
monastic orders.
• They existed as a form of collective
organisation, and they represented a way
to create a source of wealth and power
that was free from royal domination.
• In this sense, they provided their
members with a structure that protected
them from the centralised power of
autocrats.

16. A nexus of
contracts
• A dominant view in the Coasean law-and-
economics tradition is that the firm
(including in its form as the corporation)
is nothing but a nexus of contracts: the
firm is entirely a matter of contract law,
and the corporate entity, the legal fiction
of corporate personhood, is nothing but a
name for a bundle of contracts.
• Key features: Limited liability,
transferability of assets, legal personality,
centralized management,

17. A nexus with who?
Mac Donald's
• The total number of McDonald's restaurants in the United States is greater than the number of hospitals available in the
country.
• Japan is the second country with the highest number of McDonald's restaurants. It has about 2975. Also, China has 2391, and
Germany has 1470 to emerge third and fourth, respectively. McDonald's serves more than 70 million customers daily. It was
reported that the customer traffic recorded by McDonald's is greater than the entire population of the United Kingdom.
• McDonald's sells an estimated 80 hamburger every single minute worldwide.
• Contracts with vendor of supplies (beef, cheese, milkshake), employment contracts (alchemy; usually from teenagers that
can’t even be trusted to clean their own rooms), suppliers of capital etc

18. The importance of
specialization
• The emergence of the corporate structure is as important in transforming commerce as the
assembly line is in mass production. Both are based on ‘specialisation’.
• Specialisation is at the core of the corporate form. For example, you don’t need to know how
to make a complete chair to work in a chair factory – your job is likely to be simply to put the
chair leg into the seat. You don’t need to know how to make a chair to invest in a chair
company. All you need to do is to buy some shares.
• The corporation form – in particular, the joint-stock company – is necessary for the efficient
organisation of talent, money and other factors and energies in the pursuit of technological
and industrial progress.

19. Why has there been such
as large uptick in interest
in corporate governance?
• Globalisation
• Scandals
• Deregulation
• Financial crises
• Shareholder activism
• The growth of firms

20. The Asian Financial Crisis in 1997/1998 provided
the following lessons:
• Weak corporate governance system
characterised by cronyism and corruption
distorts the efficient allocation of resources.
• It undermines opportunities to compete on
a level playing field.
• It leads to failure of confidence, which
spreads rapidly from individual companies to
entire economies.
• It ultimately hinders investment and
economic development.

21. There are a number of ways in which we believe better
corporate governance can contribute to economic
improvements. These include the following:
• Good corporate governance promotes the efficient use of
resources both within the company and the economy.
• It helps debt and equity capital flow to the most efficient
users.
• It is capable of the timely replacing of those managers who
do not put scarce resources to efficient use, or are
incompetent, or corrupt.
• It helps to boost both domestic and international investors’
confidence, and thus assists companies (and economies) to
attract lower-cost investment capital (both debt and
equity).
• It provides incentives to the board to ensure compliance
with the laws, regulations and societal expectations.

22. Benefits of good
governance
• Although better governance does
not guarantee improved
performance at the individual firm
level, it makes companies more
actively respond to changes in
business environment.
• It is a check on the power of the
relatively few individuals within the
corporation who control large
amount of other people’s money,
thus reducing the likelihood of
corrupt behaviour.

23. Unit 2 Theory of the Firm
• Competition and Cooperation
• Market Contracting Costs versus Ownership Costs
• Recent Unconventional Developments
• More on Complementary Perspectives
• Conclusion

24. What is ownership
• Owners are parties that have two rights:
control of the firm & ability to appropriate
residual earnings/profit
• Co-operatives and firms

25. Competition and
cooperation
How we view the firm depends on the
theoretical perspective from which we
are viewing it. There are two broad
views:
1. Competition focused ‘black box’
approach: production function
that aims to maximise profits.
(no soul; did Jay-z sell his soul)
2. Cooperation amongst interest
groups to minimize transaction
costs

26. Choice vs contract
Another similar theory is the choice vs contract theory developed by
Olivier Williamson.
Science of choice refers to the orthodox ‘black box’ approach i.e no soul.
The science of contract refers to individuals seeking to secure their own
private interests through contracts.

27. Choice vs
contract II
• Williamson divides the contracts into
private and public ordering.
• Public ordering concerns the rules of
the game, affairs to do with public
finance and political concerns. Politics
is a system of complex exchange
between individuals where people seek
to collectively secure their own
objectives that can’t be secured
through market exchanges-Buchanan,
1987. Non-market strategy.
• Private ordering refers to the ‘play of
the game’, incentive alignment to deal
with the problems of contracting as
well as implementation of existing
contracts. Private ordering refers to
self help efforts by parties to a
transaction to find the optimal
structure.

28. Ministry of enjoyment:
Choice vs Contract
• Economics throughout the twentieth century has been developed
predominantly as a science of choice
• Choice has been developed in two parallel constructions: the theory
of consumer behavior, in which consumers maximize utility, and the
theory of the firm as a production function, in which firms
maximize profit.
• But the science of choice is not the only lens for studying complex
economic phenomena, nor is it always the most instructive lens.
The other main approach is what James Buchanan (1964a, b, 1975)
refers to as the science of contract.
• Internal organisational structure emerged as an attempt to
minimise transaction costs. This ‘cooperation’ approach focuses on
how and for what reasons a given organisational structure emerges.
In this model, the firm is no longer viewed as a ‘black box’, but
instead as a series of contracts designed to minimise the costs
associated with economic activity.

29. Investor-owned firms vs Employee-owned firms vs Consumer owned firms

30. Market Contracting Costs versus Ownership Costs
Market Contracting Costs
• Market Power: a firm may gain market power either through its large scale, or regulations that limit competition. When a firm exploits its market power there is a private cost
to the consumer in the form of higher prices, and a social cost that results from a distortion in consumption from selling at a price above the market-clearing price.
• ‘Lock in’ cost: a follow-on from market power. Firms with market power may use this power to lock in various forms of stakeholders from investors to suppliers. For example,
suppliers can become dependent on the business of a single large firm. Capital investors can be easily locked in to asset-intensive firms. Can you suggest some reasons to
support the argument that investor ownership might be preferable in the lock-in situation?
• The risks of long-term contracting: firms have incentives to enter into long-term contracts to prevent opportunistic behaviour. However, even long-term contracts can become
risky if conditions change.
• Information asymmetry and moral hazard: this becomes a problem when one party to the contract has more information than the other. For example, a firm may know more
about the quality of goods that it sells leading to distrust in the marketplace. Company directors may not monitor management with the same vigilance as owners. This may
lead to moral hazard or shirking of responsibility. Consequently, the market becomes characterised by opportunistic behaviour and costly strategic bargaining.
• Difficulties in communicating and aggregating diverse preferences across different contracting parties: market contracting may lead to inefficient contracting across parties.
Ownership costs
Ownership has two main features – the exercise of control and the receipt of residual earnings. The costs of ownership are therefore dependent on these two features.
• These costs can be divided into the costs of controlling managers, the costs of collective decision-making and the costs of risk bearing.

31. A chair
• Fama and Jensen (1983) see the separation of
ownership and control as a separation of
decision-making and risk-bearing functions. They
contend that organisations not only benefit from
this specialisation in management and risk
bearing, but also from a common approach
between owners and managers to controlling
agency problems resulting from this separation.
• The owners don’t need to know how to
manufacture the chair, but they can invest in a
chair making factory.

32. Both the ability and fidelity of managers have long needed monitoring. Indeed, nearly 2,000 years ago,
Jesus Christ addressed this subject, speaking (Luke 16:2) approvingly of “a certain rich man” who told
his manager, “Give an account of thy stewardship; for thou mayest no longer be steward.”

33. Back to
ownership
• Shareholders delegate their executive power – as ‘owners’
– to the managers, who actually run the business.
• However, management objectives can potentially be in
conflict to those of shareholders. These potential conflicts
may concern business strategy or financial decision making
such as, for example, the structure and amount of
executive compensation.
• These ‘agency conflicts’ constitute a key issue with respect
to corporate governance. The quality of shareholder
control of the managers becomes essential for the good
governance (Fama and Jensen, 1983).

34. Unconventional
developments
• The rise of institutions as the dominant form of investors, the increasing
popularity of employee ownership, producer-owned cooperatives and
widespread state-ownership, all challenge us to take a wider view of
ownership and contracting. These are significant because they impact
upon the level of contracting and ownership costs, thereby affecting the
governance arrangement of firms.

35. The era of institutional
investor
The rise of institutional investors has created a three-way
separation of ownership and control involving:
1. Direct shareholders (owners of shares)
2. Indirect shareholders (fund portfolio management)
3. Executives (firm managers)
One of the major changes that institutional investors
bought about is in investment strategy. Majority of
institutional investors take a ‘passive’ investment stance
aiming to match funds to standard index returns. This
contrasts with active investors that aim for better than
market returns.

36. Enter venture Capital:
The tech bros
• Joint ownership refers to the sharing of ownership rights between a
capital-constrained entrepreneur and a number of venture capitalists who
are willing to finance the entrepreneur, contingent on the firm’s
performance.
• They have strong incentives to maximise value but receive few private
benefits of control. Consequently, they face significant agency costs in
monitoring entrepreneurs.
• According to Kaplan and Strömberg (2001), this is achieved in three
closely connected ways:
i. sophisticated contracting
ii. pre-investment screening
iii. post-investment monitoring and advising.
• The equity involvement of venture capitalists provides an incentive for
them to engage in costly support activities to enhance the value of the
venture or to limit potential losses.

37. • State Owned enterprises: A firm that
faces a soft-budget constraint, whether
private or state-owned, would have little
incentive to take financial pressure
seriously.
• Co-operatives: Mondragon Group in
Spain and the La Lega Network in Italy.
Mondragon Group and La Lega are two
examples of worker-owned cooperatives
in practice. Workers are more motivated
and aligned. However, much harder to
attract external investment and there
are large costs because of the cost of
collective decision making.

38. Corporate Governance and the Role of Law
Unit 3

39. Corporate
Governance
& the Role
of Law
Unit 3
• The Basic Question in the
Debate: Dispersed vs
Concentrated
• Competing Explanations
• The Rise of Equity Culture in
the EU
• Historical Perspective
• The Implications of the
Global Financial Crisis: The
Case of Hong Kong
• Implications for Transition
and Developing Economies

40. The great debate
This is the dispersed ownership system, which
tends to be associated with the US and the UK
Vs
The concentrated ownership system, which is
more common in continental Europe

41. Dispersed
• A dispersed ownership system is characterised
by widely dispersed shareholders.
• Under such systems, securities markets and in
particular stock markets tend to be active, with
large volumes traded daily. Shareholders are
afforded a high level of legal protection.
• Consequently, listed companies must comply
with rigorous disclosure standards and markets
are highly transparent.

42. Concentrated
• Ownership is characterised by large
controlling block-holders.
Securities/stock markets tend to be
weaker and less active than those
in dispersed systems.
• There are high private benefits of
control and low standards of
disclosure and market transparency.
Banks as shareholders and creditors
play a principal role in monitoring.

43. Why are some
countries
characterized by
dispersed ownership
whilst others by
concentrated
ownership?

44. Competing explanations: Political
explanation vs Legal explanation
• Obama is a lawyer and a politician
• Some which one do you agree with

45. Legal Explanation
• Common-law countries such as the US and the UK generally provide the strongest levels of investor protection. French
civil law countries have the weakest legal protections of external investors, with German and Scandinavian civil-law
countries located in the middle.
• Therefore, common law allows for more investor protection and hence greater levels of investor protection are seen
compared to civil law countries. Under the common law system, judges apply precedent to deal with new cases that
may or may not be covered by existing legislation.
• Investor protection encourages the development of financial markets. In countries with poor protection, firms suffer
from over reliance on bank funding.
• In civil law system, laws are made by legislatures and judges cannot go beyond these statutes. The judiciary is expected
to make judgments based on legislation and are therefore constrained in dealing with cases not covered by existing
legal statutes.
(La Porta, Lopez de Silanes, Shleifer and Vishny)

46. Political
explanation
• The political explanation argues that it is politics, not the
law, which is the critical determinant of the corporate
governance system.
• The principal proponents of this approach are Mark Roe
and Lucian Bebchuk. Roe and Bebchuk take a path-
dependency approach, which argues that institutions
evolve in a path dependant manner and are shaped by the
historical starting point and pre-existing conditions.
• By path dependent, we mean that the type of institutions
that develop will very much depend on the conditions that
existed prior to the development. In other words, you can
almost predict the outcome, if you know what the pre-
existing conditions are.

47. Differences between the legal &
political explanations
• Politics is key
• Any legal differences stem from deeply rooted political
values. E.g social democracies will place political
pressure on companies not to downsize during a
recession or forego some profit-making activities etc.
Since only concentrated large shareholders can
effectively compel managers to resist these political
pressures, the structures in many European countries
have evolved in the most efficient manner for that
political environment.
• A Finnish sauna

48. Bernie Sanders
• Roe argues that its an absence of
social democracy in America that
has resulted in dispersed
ownership of companies. So if
Bernies Sanders had won?
• Bebchuk argues that in
environments when the benefits
of concentrated control are high,
entrepreneurs are less likely to
sell. This behavior is known as
rent protection

49. 4 main criticisms of the
political explanation
1. The analysis is based on the same time-invariant correlation
analysis as in the law-determinant perspective.
2. There is also a problem with the logic of the argument. Why is it
not the case that it is politically safer and easier for a
government to pressure a few large block holders than an
anonymous herd of small investors?
3. Just because we establish a strong correlation between two
variables does not mean that there is a cause-effect
relationship. E.g securities markets and concentrated ownership
were already established in Germany and France in the
nineteenth century, well before the rise of social democracy.
4. The numbers, European IPO’s climbed between 1990 and 2015,
whilst UK and US declined. Plus there have been takeovers of
European firms, most notable German telco: Mannesmann in
the absence of major legal reform. Just mostly because the
world is changing in terms of openness to trade, mass
privatisation, liberalisation of cross border capital flows,
European capital market integration (leading to competition
across stock exchanges) and the demands for venture-capital
financing in the high-tech sectors. The tech bro effect.

50. Deep dive 1: Global corporate governance:
On the relevance of firms’ ownership
structure
• Published by Ruth Aguilera
• Journal of World Business
• The political sociology and political economy perspectives underscore the
relevance of ownership structure in the cross-national context, particularly as
it influences the types of capitalisms that have developed over time as well
the salience of different country organizations and the accountability of
managers to society
• The diverse nature of the agency problem, first among shareholders and
managers, known as Principal-Agent or type I and then among large and
minority owners, known as principal–principal or type II.
• Positive elements of family firms such as lower agency costs, long term
perspective to ensure the continuity of firms under family control for future
generations, and propensity to diversification strategies to reduce the natural
risk concentration of family wealth in a single or reduced number of firms,
products and markets.
• Why America is rich and Africa is poor? Innovation. (Private thoughts)

51. Deep Dive 2: The Rise of Dispersed
Ownership: The Roles of Law and the
State in the Separation of Ownership and
Control
• By John Coffee. Yale Law Journal
• Its 82 pages!
• LLSV debate on common law versus civil law may have
obscured the importance of a previously hidden variable: the
level of government involvement in economic decision
making
• Securities exchanges and dispersed ownership are correlated
to low levels of government intervention in the private sector
e.g state run Paris bourse vs privately run LSE
• Bank centred economies facilitate more government control
over investment flows compared to non-bank centred
economies. Sound familiar Nigeria?
• LLSV may have got it backward. They argue that a strong legal
system creates a stronger private sector investment
environment, but perhaps a strong private sector creates
demand for strong laws. Chicken or the egg?

52. History from the
UK, US & France

53. The
American
Experience
• From 1860-1930’s
• The development of equity markets in the US was largely
driven by the enormous capital demand of its railway lines.
• 40% of this capital is estimated to have come from Europe via
London and Paris.
• Block holders were powerful. They could bribe judges and
manipulate investments that’s why they were called ‘robber
barons’ because of their power to expropriate minority
shareholders. Investment bank reputation became very
important, how else could an investor in Europe monitor an
American company?
• It was the investment bankers like JP Morgan that ensured that
he had board seats in companies which enabled his bank to
monitor investments on behalf of foreign clients. Also the
NYSE developed strict rules which allowed it to thrive more
than the Boston Stock exchange that didn’t, even though they
competed at the time.

54. The UK experience
• Before WWI the London stock exchange was
an open exchange with broad membership
and fewer laws than America as corruption
wasn’t as much of an issue.
• Looking at both US and UK neither had a
legal protection system early on, they were
put in place in response to crises.

55. The French Experience
• The Paris Bourse was always a state-controlled
monopoly with a high number of state owned and
family firms. It also focused more on bonds and
securities rather than equity.
• Its important to read history correctly. Legal protections
were either nonexistent or difficult to enforce because
of judicial corruption. The major difference between
the UK/US experience and the French experience was
the presence of state intervention in corporate activity.

56. The Implications
of the Global
Financial Crisis:
The Case of
Hong Kong

57. Hong Kong and the global
financial crisis
• International banking: 69 of the world’s 100 largest banks have offices in
Hong Kong
• Foreign exchange trading: the world’s sixth largest centre
• FDI: the world’s largest seventh largest recipient and Asia’s second largest
• Stock market capitalisation: seventh highest in the world and third in Asia
• IPOs: fourth largest in the world and second in Asia
• In the aftermath of the global financial crisis despite its history as a British
colony, therefore similar legal structure to the UK, Hong Kong was relatively
unscathed financially due to strong regulation, corporate governance and
supervision. Regulation isn’t the same thing as poke nosing/ personal
interest centered interference.

58. Lessons for emerging and
transition economies
• Strong regulation i.e Hong Kong
• Free market competition goes hand in hand
with capital market development
• Legal bonding can occur when companies in
emerging markets list on foreign stock
exchanges
• Competition domestically or internationally
between stock exchanges can induce self
regulation

59. Race to the top vs
Race to the bottom
John Coffee presents two possible
future scenarios that could occur in
countries with weak investor
protection as companies from these
countries continue to cross listing on
foreign exchanges to improve their
growth prospects.
(Coffee, 2002)

60. Race to the top
• One scenario they present is a "race to the top". In
this scenario, countries with weak investor
protection rapidly improve their corporate
governance standards in order to compete with
larger foreign exchanges. In some cases, they
envisage that regional "super" exchanges will be
formed to provide the depth and liquidity along
with the associated regulation/transparency
required to provide investors with comfort.
• There are examples of countries/regions that this
has begun to happen. Since 2000, the major Latin
American markets-Argentina, Brazil, Chile, and
Mexico-have passed major corporate governance
reform legislation. One of the major factors that
influenced this new legislation appears to have
been the loss of liquidity in Latin American
markets as a result of listing migration to the New
York Stock Exchange (NYSE).

61. Race to the bottom
• The second potential future scenario is the "race to the
bottom" scenario. In this case, countries with weak
investor protection are unable to respond rapidly
enough with appropriate corporate governance
reforms partially due to entrenched private interests
that lobby against regulation and reform to maintain
the benefits of private control for their companies. As a
result of this lack of reform, global capital flows
gravitate to a few trusted stock markets.
• In this scenario, a virtuous cycle is created where the
good reputation, transparency and liquidity of these
chosen few exchanges attract more foreign companies
to cross list on them. The fact that these stock
exchanges attract the world's largest and most
innovative companies with the best returns,
encourages more investors, increasing their depth and
liquidity.

62. Unit 4
Corporate
Governance Around
The World

63. Unit Overview
• A Framework for Comparison
• Equity Market-based System versus Bank-
led System
• Family-based Corporate Governance in
Asia
• The Pyramid Structure and the Internal
Capital Market
• State-Owned Business Groups: Protection
or Expropriation
• Conclusion

64. Comparing corporate governance from three different perspectives:
• Internal corporate governance: reporting, incentive structures e.g profit share
• Governance at the level of the board of directors: the cord that connects internal structures to
external environment
• The external corporate governance environment : Legislation, capital markets etc

65. Equity systems: Bank
based vs Market based
Internal Governance
In a market-based system employees have stock options, but in a bank-based
system employees are protected by strong labor laws. Culturally, in market-based
systems there is a prevailing short-term perspective, whereas in a bank-based
system there is a more long-term perspective. Bank based systems also have less
appetite for risk and less transparent reporting compared to market-based
economy. Link to innovation.
Mayer (2000) argues that ‘outsider’ systems have a ‘market control bias’. This
means that the more outside equity that is raised, the less control the original
owner is likely to have. As a result, the original owner or supplier of finance is likely
to have a short influence or control period. Conversely, an ‘insider’ system is more
likely to have a ‘private control bias’ and thus a longer influence or control period.
Insiders can therefore retain control through holding voting shares or anti-takeover
pacts with other investors.

66. Governance at board level
In market based the board plays a central role whereas
in bank based it’s a lesser role, usually due to the banks
over-riding role.
In terms of incorporation, banks have more of a
stakeholder perspective whilst market-based systems are
more focused on stakeholder value.
External corporate governance
Market based systems tend to have laws that protect
minority shareholders. In bank systems capital market
liquidity is low, external monitoring is limited and there
is reduced threat of takeover.
Mayer (2000) suggests that the more outside equity that
is raised, the less control the original owner is likely to
have.
Under a market-based structure, shareholders are
dispersed, whilst under bank they are concentrated and
usually related to the bank. The same for ownership
structure.

67. Deep Dive: ‘International
corporate governance’
• By Denis D & J McConnell (2003)
• The typical large U,S, corporation, with its diffuse equity
ownership structure and its professional manager,
appears to be typical only in the U,S. and the U.K.
Ownership concentration in virtually every other country
is higher than it is in these two countries. In many
countries, majority ownership by a single shareholder is
common.
• A country's legal system in particular, the extent to
which it protects investor rights—has a fundamental
effect on the structure of markets in that country, on
the governance structures that are affected by
companies in that country, and on the effectiveness of
those governance systems.

68. Family-based
Corporate Governance
in Asia

69. • Families typically control the
board and minority
shareholders have weak
protection
• Board members are usually
part of the family or loyal to
the family

70. Pyramid
structures
• The pyramid structure, as its name
suggests, is essentially a control chain
with a wide base at the bottom and a
narrow control point at the top.
• This allows the controlling family to
exercise its control from the top of the
pyramid over a larger range of companies,
with a relatively small ownership stake.
• The controlling family does not need to
own all the shares in each individual
company. Instead, it only needs to own
enough to control the voting.

71. • Case study from China: Advantages of business groups
include their ability to reduce transaction costs by filling
institutional voids in addition to this they are good at
absorbing new technology to improve efficiency and
profitability. However, they are also associated with higher
levels of rent seeking, moral hazard and inefficient
investment
• Such “control pyramids” allow a firm (often family or state
owned) to control several publicly listed companies, each of
which may in turn control yet more listed companies. This
happens without commiserate investment
-Sunderland D & L Ning (2015)
State owned enterprise

72. Unit 5 Board
composition and
control
Unit Overview
• Board Composition and Control: Practical
and Theoretical Trade-offs
• The Typical Anglo-American Board: Past
and Present
• The Legal Framework Governing the Board
• The Board Management Relationship in
Reality
• Director Selection
• Conclusion

73. A series of trade offs

74. Board composition
• Board of directors forms an
important intermediary between
internal and external governance
mechanisms.
• Both Berle & Means and Adam
Smith claimed that investors know
little about how their money
would be invested and
management had little care for
this money as it was not their own.
• ‘Owner managed’ banks in Nigeria

75. A democracy…sort of
• Equity holders elect a group of people to
watch over their investments to ensure
that their capital isn’t mismanaged or
even embezzled.
• As elected representatives, their purpose
under law is to protect the assets of the
corporation.
• This also affects who the directors
represent. For example, in such countries
as Germany and Japan that operate
under the stakeholder model, directors
are also the elected representatives of
creditors and employees.

76. Trade off 1: The
Practical Dilemma
• As an intermediary governance
mechanism, they must not only
represent the owners, but also
individual employees charged
with the day-to-day running of the
firm.
• Therefore their concern is not just
about running the company, but
also making sure that the
individuals running the company
run it as well as possible.

77. Trade off 2:
Theoretical concerns
• Agency theory: Act as agents, aligned with the
interest of shareholders
• Resource dependency theory: They should be able to
give advice, legitimacy and secure access to
resources preferentially
• Social network theory : There is reliance on the
social resources of directors, therefore though
relationships should be able to reduce the cost of
vertical integration
• Institutional theory: The company is one among
many related institutions that are mutually
dependent.
• Multi-theoretic view: argues that no single theory
can explain how the board works. Depends on the
power of stakeholders e.g and the stage in the
lifecycle of the company

78. The Typical Anglo-American Board:
Past and Present
• Typical in early days met on stools because
furniture was too expensive
• Colonists used to monitor JS company in
India and report to the London HQ
• 1920’s started more formal boards e.g GE

79. The Modern
Board
• Number of members: On S&P
reduced from 13 to 11 in 2004.
Maybe because demands on
directors have increased. The
largest was 24, smallest was 5.
• Diversity: More women, more
academic and NGO’s (total of 10%
in 2004)
• Committees:
Audit/compensation/selection
compulsory for listed companies.
• Inside/outside mix: There are
more outside directors than inside
compared to the past.

80. Independent Directors
• Post Enron NYSE rules require boards to have majority outside independent directors and
all committees composed exclusively of independent outsiders.
• Before this rule 13% of boards did not have majority independent directors
• Greater demands on time, increased turnover, financial expertise disclosure for audit
committee have made it impossible to serve on 8-10 boards
• Splitting chairman and CEO so agenda can be set to discuss perhaps thorny issues that the
CEO would rather not have discussed.
• General motors, HP, Amex shareholders all took the opportunity to separate roles
through shareholder resolutions at some point.
• Key trend for directors is a preference among companies to appoint either board
members or CEOs of other companies to their own board. The result is interlocking
directorships or a type of director network.
• The position of director is no longer easily filled by a friend of the board or the CEO.
Nominating committees with independent directors have adopted methodical and
transparent recruiting processes.
• Prospective board candidates are weighing more carefully the time and the risks and
rewards associated with each directorship.

81. Disney
• $130m in severance payouts to Michael Ovitz
• Wasn’t negligent, but clashed with everyone
• Didn’t seem to know how to run a listed company
• Two members of the compensation committee and
an outside consultant negotiated employee
agreement without knowledge of the rest of the
board
• Supreme court of Delaware ruled in favour of the
board

82. Warren Buffet
• He talked about sugar daddies in his 2002 report
using an andecdote of an 85-year-old man
would asking his much younger wife if she
would still love him if he lost all his money, and
her reply would be ‘I would miss you, but I
would still love you’. He said that directors
should take the same atttide no matter how
likable the CEO is.
• He has sat on 19 public company boards and
interacted with over 250 directors, but said that
most of them were good people, but didn’t
know enough about the business or care enough
about shareholders to be effective. He admitted
his own failings too, sometimes he was too
polite and kept silent when he should have
spoken up.

83. Board Tasks
The following is a brief list of tasks the board needs to attend
to:
• quarterly results and management’s projections for the
next quarter
• long-term strategic goals
• capital and debt structure
• the need to buy or sell assets
• dividend policy
• research and Development projects
• the status of the major competitors
• the company’s global prospects.

84. Deep Dive:
Corporate
governance
& the global
financial crisis
• David Erkins; Journal of Corporate Finance
• Using a unique dataset of 296 financial
firms from 30 countries that were at the
center of the crisis, we find that firms with
more independent boards and higher
institutional ownership experienced worse
stock returns during the crisis period.
• Further exploration suggests that this is
because (1) firms with higher institutional
ownership took more risk prior to the
crisis, which resulted in larger shareholder
losses during the crisis period, and (2)
firms with more independent boards
raised more equity capital during the crisis,
which led to a wealth transfer from
existing shareholders to debtholders.

85. American
Express: Case
Study
• 1977 James Robison elected
Chairman of Amex and CEO.
• Vision to create a financial
supermarket: everything that
could be paid
• Acquisition spree: Shearsons @
$1bn, the Boston Company, a JV
with Warner communications to
launch a TV channel- sold before it
became very successful, Lehman
brothers, Trade development
bank, even tried to buy Disney!!!

86. The losses
• 240m at one of the insurance
companies, partner accused Amex
of a smear campaign, ‘accounting
errors’ at another company where
profits where overstated and
directors fired, the Boston ‘fee
party’ where restaurant owners
cut up their amex cards to protest
high merchant fees, transaction
involving a UK company blocked,
reputational damage through the
press.
• Biggest problem was Shearsons,
declining earnings, Moody’s
downgrade

87. The showdown
(1991-1992)
• Robinson had been in office about 16 years,
one of the longest tenures for a corporate
chief ever in American history
• Losses of $116m when every other company
was booming
• Warner asked for a private meeting on only
outside directors schiedlued for 1992
• Supper meeting Warner read out the
dismal, scathing performance of Robinson
and asked board to fire him immediately.
• A search committee was formed started
looking for replacement, Robinson suggest
Golub; a senior inside manager. Some board
members wanted an outsider.

88. The boys club
• All directors except two had been handpicked
by Robinson
• Many had received consulting fees from him
into their private consulting firms
• Interlocking; they also sat on other boards
with him which made them chummy and
cozy
• Robison therefore was able to get majority of
the board to vote to retain him as an
executive and Golub as new CEO.
• However, share price dropped as a result of
that decision. Investors like JP Morgan
started complaining, eventually he admitted
that position was untenable and resigned.

89. Excerpt from
Warner's
‘Director of the
Year’ Award
Acceptance
Speech

90. Back to
ownership
• America’s boards have often failed to protect the
interests of shareholders
• We demand a lot of them, considering that they
are typically selected, compensated and
informed by those they are supposed to be
overseeing.
• Boardroom politics are typically dominated by
the CEO, who has access to the full apparatus of
the corporate public relations department and
of other establishment figures. In addition to the
traditional discipline of market, recent moves in
improving corporate democracy are being driven
by investor activism, and institutional investor
activism in particular.
• ‘A market for independent directors’ may
emerge, because increasingly shareholders are
looking to outsiders to take the lead on board
issues. But they also have their limitations.
• The key to a good board has been argued by
Monks and Minow to be ownership. If each
directors personal net worth is closely tied to
the company, no director will remain silent if
25% or even 10% of his/her net worth is at
stake.

91. Unit 6
CEO Compensation

92. Unit Overview
• Introduction: Major
Challenges Faced by CEOs
• Why CEOs Fail
• An ‘Ideal’ CEO
• CEO Compensation and
Employment Contract
• Stock Options
• Case Study: General
Electric
• Conclusion

93. Learning outcomes
• identify the key challenges faced by CEOs,
particularly with regard to the changing
corporate environment and the increased focus
on corporate governance
• outline the internal, external and personal
factors that lead to CEO failure
• critically evaluate the functions of the ideal CEO
and explain how they differ from the reality.
• discuss the controversial issue of CEO
compensation and explain why higher
compensation does not necessarily create the
correct incentives
• explain why specifying the correct compensation
contract for CEOs is such a complex problem in
corporate governance.

94. Major Challenges
• Previously CEO’s were viewed as kings. Now the king is dead.
• Post Enron/GFC
• More focus on accountability and performance
• More short runners, fewer long runners
• Must be powerful enough to do the job, but accountable enough
to ensure job is done correctly

95. Implications
of changes
CEO’s want job security, shareholders
want pay to be based on performance.
Finding a balance?
Aspire-perspire, motivation and
inspiration may give a temporary boost
to share prices, but short shelf life
Avoid the success trap of long running
CEO’s. Always right/arrogance.

96. Why CEO’s fail
• When a company is failing it will try almost anything. But
when a company is successful it generally does not know
why … like an athlete on a lucky streak who won’t change
his socks, it will fall into an almost superstitious pattern of
not changing anything.
Source: Monks and Minow (2004)
There are no hard and fast rules for CEO success.

97. Why CEO’s
fail? II
Fortune magazine survey
People problems
Execution problems
Decision gridlock

98. “Say you have a dog, but you need to create a duck on
the financial statements. Fortunately, there are
specific accounting rules for what constitutes a duck:
yellow feet, white covering, orange beak. So you take
the dog and paint its feet yellow and its fur white and
you paste an orange plastic beak on its nose, and then
you say to your accountants, ‘This is a duck! Don’t you
agree that it’s a duck?’ And the accountants say, ‘Yes,
according to the rules, this is a duck.’ Everybody knows
that it’s a dog, not a duck, but that doesn’t matter,
because you’ve met the rules for calling it a duck.”
-Bethany McLean, The Smartest Guys in the Room:
The Amazing Rise and Scandalous Fall of Enron

99. The ideal CEO

100. The ideal CEO
• Integrity, maturity and energy
• business acumen, a deep understanding of business and a strong profit orientation, an almost instinctive feel for how the company makes
money
• people acumen, judging and leading the team and coaching people, removing incompetent people on time, organisational acumen,
engendering trust, sharing information and listening
• focusing on execution and decisiveness; simplifying the organisation for speed and efficiency
• ability to change, not just to run the business
• delivering on commitments
• curiosity, intellectual capacity and global mindset
• extremely oriented and hungry for knowledge of the world
• adept at connecting development and spotting market patterns
• strong motivation to grow and convert learning into practice
• an insatiable appetite for accomplishment and results.
Notice how many of these refer to such unique personal qualities as intuition and enthusiasm, and also the political skill of the CEO. ‘Political
skill’ in this context refers to the ability to get on with subordinates in a way that gets things done.

101. CEO
Compensation:
Scenes from a horror
movie

102. • When the compensation committee – armed
as always with support from a high-paid
consultant – reports on a mega-grant of
options to the CEO, it would be like belching
at the dinner table for a director to suggest
that the committee reconsider’- Warren
Buffet (The Economist,2003)
• Buffet refers to the boardroom atmosphere
as crucial in determining the type of salary
rather than inadequate laws or legislation.
• Two other concerns: a. Link between pay and
performance. b. Social inequality
• DS Executive Compensation Review via BBC
indicate that the relationship between CEO
pay levels, share price performance and
financial performance is, at best, tenuous. At
worst, there is no relationship at all. In fact,
the statistics show little evidence to indicate
a correlation between CEO compensation
and performance.

103. Renumeration
during the global
financial crisis
During the GFC share prices fell,
several large banks became insolvent
and would not have been able to
continue to finance their operations
were it not for government support.
In the US, nine large banks
collectively received US$165 billion
from the US government under the
Troubled Asset Relief Program. The
same banks paid out almost US$32
billion in bonuses that year, of which
47 presumably senior directors
received bonuses of over US$10
million.
Nothing should disrupt the soft life

104. Why does this
happen?
• Of the small group of
individuals at the top of
the earning scale,
including rock stars,
movie stars, top athletes,
investment bankers and
CEOs, only CEOs pick the
people who set their
compensation
• Renumeration
committees are supposed
to be independent, but in
reality, the CEO has
power over who sits on
the renumeration
committee.

105. What happened
to Tweet?
For all other high
paying professions,
remuneration is
closely related to
performance.

106. • A second reason this CEO’s get paid high amounts even when they don’t
perform is the way performance is measured
• How performance is measured and more precisely what measures are used
against which to benchmark performance. The most simplistic and readily
available measure of performance for a listed company is its share price.
Standard measures include Earnings Per Share (EPS) and Total Shareholder
Return (TSR). Both of these measures are essentially focused on the
company’s share price and as such they are short-term in nature.

107. Change in the air?
• A number of high profile cases of shareholder activism involving such large companies as Glaxo-
Smith-Kline (GSK) and Shell have witnessed some backtracking on overly generous awards. In the
aftermath of WorldCom and other corporate scandals, the NYSE has issued new regulations
regarding the composition of board level committees.

108. What about
incentives?
There is no incentive plan
that can make a weekend
athlete into an Olympic
gold medallist. And no
incentive plan will make a
CEO who is in over his
head suddenly able to
turn the company around.
- Monks and Minow
(2011)

109. Why incentives are flawed
Joseph Stiglitz (2010) a former winner of the Nobel Prize for Economics has put forward some powerful reasons for why he believes the
system of incentives is flawed. His principle argument is that a better alignment of private rewards (i.e. remuneration) and social returns and
better regulation including that of incentives, has better prospects of incentivizing innovation.
The six basic points he makes are highlighted below:
1. Flawed incentives encourage excessive risk taking and short-sighted behaviour.
2. Flawed incentives explain why the financial sector failed to innovate in ways that would have been better for society.
3. Poorly designed incentive structures often lead to creative accounting and declines in product quality, since there is an incentive to
maximise returns.
4. Incentive structures can distort the provision of information.
5. The design of incentive structure demonstrates a failure to understand risk and incentives, and even a deliberate attempt to deceive
investors.

110. Share buybacks
• One increasingly controversial way in which CEOs can manipulate
their pay is through the misuse of share buybacks. Share
buybacks have long been viewed as way of returning value to
public shareholders since they increase the share price.
• Its obvious how share buy backs can be manipulated to transfer
wealth from shareholders to executives
Relationship between share buybacks and the following:
i. income inequity
ii. unemployment
iii. economic instability
iv. diminished innovative capability.
(Lazonick, Brookings)

111. Lazonick calls for a decrease, or even a ban, in
stock buybacks so companies will be able to use
these funds to finance capital expenditures but
more importantly to attract, train, retain, and
motivate its career employees. And some of the
funds made available by a buyback ban can even
flow to the government, he argues, as tax
revenues for investments in infrastructure and
human knowledge that can underpin the next
generation of innovation.
(Brookings)

112. HP Case study
• In the case of HP, their former CEO, Carly Fiorina, received a golden handshake worth up to US$42
million. Ms Fiorina, who was supposedly dismissed for not meeting targets, had clauses written
into her contract five years earlier that required such compensation in the event of her being
forced to leave.

113. Stock options
Stock options are the 800-pound gorilla that has yet to be caged
by corporate reform. Corporate scandals have shown how
current U.S. accounting rules are fuelling stock option abuses
linked to excessive executive pay, dishonest accounting, and non-
payment of taxes by profitable corporations. International
accounting experts have already proposed treating stock options
as an expense, and FASB ought to follow their lead. Honest
accounting of stock options would strengthen the accuracy of
U.S. financial statements and help restore investor confidence in
our financial markets.
-US Senator Carl Levin, FASB (2004)

114. What is a stock option?
• A stock option is the right to buy a company’s stock at a fixed price for a fixed period.
Stock options work by granting a CEO the right to purchase stock at today’s trading
price for a period of five to ten years. If the stock goes up, the CEO can cash in the
increase. If the stock goes lower than the option price, the CEO can refuse to exercise
the right.
• Since the 1990s, stock options have become a central if controversial aspect of CEO
pay. A case in point is Disney. In 1999, its CEO Michael Eisner took home US$575
million, mostly in stock option gains.
• Because popular because they seemed like the best way of linking compensation to
performance. The argument goes that the CEO will not make any money from the
option unless the company’s share price goes up. Therefore, at least in theory, the CEO
should have a strong incentive to maximise increase in share price. Since an improved
share price also improves shareholder value, the logic is that the incentives of CEO and
shareholder have been aligned. Perfect? Or not….

115. Why stock options can
be problematic
I’ll be happy to accept a lottery ticket as a gift…but I’ll never buy
one.’
-Berkshire Hathaway Inc. (1985)
• No owner has ever escaped the burden of capital cost,
whereas the CEO as holder of a fixed-price option bears no
capital cost at all. Secondly, the link between a company’s
performance and share price is less than clear-cut. In fact
most CEOs understand that market sentiment and industrial
factors account for major movements in share price. As such,
stock options may in fact represent an option on the
performance of an index such as the FTSE 100 or S&P 500,
rather than the performance of an individual company.
• Restricted locks may improve alignment, but reduce risk
taking

116. AOL-Time Warner Case Study
• An example is AOL Time-Warner, a well-known international media and
entertainment company. In 2003, AOL Time-Warner faced six class-actions
from shareholder lawsuits over its falling share price and allegations that a
pump and dump strategy was employed by directors. Shareholders claimed
that top executives inflated the price of AOL stock and promptly cashed in
their stock options. Shareholders also alleged that directors continued to sell
shares while using company money to finance a share buyback programme
to support the share price, and that earnings were overstated by over US$1
billion (BBC News, 2003).
• In the case of AOL, as a result of shareholder activism, the company
‘voluntarily’ reformed the manner by which stock options are granted
including the following:
i. performance-based cash bonuses, stock options and restricted share
grants
ii. new stock ownership and retention guidelines
iii. executive owners were expected to hold stock in the company at a
multiple value of their base salaries
iv. executives were expected to retain a high percentage of any gain made
from exercising options in the form of ordinary stock.

117. Shareholders are
becoming more savvy
• In 1988, 3.5% of shareholders voted against
stock options, suggesting that originally
shareholders may have considered them a
good idea. However, since then shareholder
disillusion has grown. By 1991, 12% of
shareholders voted against them. In 1998,
shareholders defeated 15 proposals, and a
further 270 proposals had at least 30%
opposition. These voting patterns suggest a
trend where shareholders, particularly
institutions, are becoming more
sophisticated regarding CEO compensation.
(Investor Research Responsibility Institute. )

118. The house that Jack built: GE
Jack Welch, the CEO of General Electric (GE) between 1980 and 2001
• Stepped down in 2001 winning awards such as ‘the most admired company
in the world’ and ‘ceo of the century’. 23% growth in shareholder return per
annum.
• GE founded in 1878 by Thomas Edison
• Jack became CEO in 1981. For the first few years he was known as neutron
jack. Streamlined workforce, by cutting 60,000 jobs. Sell, fix or close strategy
focused on being number 1 or 2 in each industry like Dangote in Nigeria.
Changed metrics from internal to external e,g market share. Made $11bn
from divestments and 370 acquisitions. Revenue grew modestly, profit
skyrocketed.
• Jack 2.0 : Moved away from neutron Jack. Lectured in the development
centre, work out sessions for all departments with the boss of that
department out if the room so they could speak freely, stretch targets in
addition to normal projections, culture, weeding out managers that were
actually delivering on numbers but didn’t align with culture.
• Service business were layered on top of products. Financial services also.
• Six sigma introduced to help with quality issues
• A players with the 4 E’s, energized towards turbulence and ability to execute
• Digital initiative as final parting program, even though late to the internet
game.
(GE’s Two-Decade Transformation: Jack Welch’s Leadership. Harvard Business School, Case Study 9-399-150.)

119. Summary
Thorny issue
Gap between
compensation
and
performance
The ideal CEO
Share
buybacks
Stock options:
pros and cons

120. Unit 7
International
Governance

121. Unit 7 Overview
Corporate Governance has Gone
Global!
Why Do Companies List Abroad?
Crisis-Driven Reforms in Emerging
Markets
Reforms in the Developed World
The Case of DaimlerChrysler
Conclusion

122. A victorious private sector?
• Excluding China most governments, even
social democracies stay out of business
• Businesses have reduced industrial activity
• Private sector has become the biggest
generator of jobs, innovation and economic
growth
• The corporation has also gone global in its
search for cheaper inputs/labour/capital
• In 1988, 2% of US pension fund assets ($48
billion) were invested overseas; in 1998, the
figure rose to 12% ($800 billion).

123. Demand and supply for
capital
• Just like there is demand and supply for goods and services there is also
demand and supply for capital
• In a closed economy, the firm’s capital requirements are dependent on the
level of domestic savings. In places where domestic capital from domestic
savings is not sufficient there are many options for raising international
investors
• Just like earlier studied, international investors want certain things. A legal
system that protects them , audited accounts, reporting that showcases
future growth opportunities, ability to sell shares to the highest bidder and
fair voting rights.
• Countries benefit from trading goods with each other, but also benefit
‘trading’ capital. Recall how railroads were built in America using capital
from Europe when insufficient capital was available at the time in America.

124. The Cadbury code
(Capital Market self
regulation)
• International capital markets have increasingly
responded to the demands of international
investors for better protection.
• Self-regulation in capital markets is where the
market participants voluntarily agree to bond or
commit themselves to higher standards of business
practice.
• Self-regulation acts as a signal to investors that
even in the absence of legislative enforcement, the
market will put its reputation for better
governance practice on the line.
• The Bank of England & LSE instituted the first
corporate governance code of the modern era in
the UK in 1992. It was chaired by Sir Adrian
Cadbury (ex chocolate chief) and hence became
known as the ‘Cadbury Code’.
• The contained a list of non-binding best practice
governance practices and companies were
required to disclosure how well they adhered to
the list.

125. Why do companies list
abroad?
• Securing cheap equity capital to finance new investment
• Allowing owners to divest controlling stakes on more
liquid markets
• Preparation for foreign acquisitions
• Improving the firm’s corporate governance reputation by
committing itself to higher standards of disclosure and
transparency
• Strengthening the firm’s international reputation.
• Wole Tinubu famously listed on both the Johannesburg
and Toronto stock exchanges.
• Over 100 African companies in total are listed on the LSE.

126. Bonding
• An argument known as the legal bonding hypothesis is
prominent in the literature. This hypothesis explains how
US exchanges attract firms because a US cross-listing
signals a credible commitment to more disclosure by
making a firm subject to US legal enforcement.
• Alternatively, a US cross-listing may facilitate informal
reputation building, an argument known as the
reputational bonding hypothesis.
• The mechanisms behind both the legal bonding
hypothesis and the reputational bonding hypothesis are
theoretically plausible and they could operate in tandem,
making it empirically difficult to disentangle their effects.
(Licht, et al., 2017)

127. Benefits of cross listing
Research by Ferris et al (2009) points at
several reasons that companies cross list.
These include liquidity,
marketing, exposure and
technical reasons

128. Benefits of cross listing II
• Liquidity: New capital acquisition is the most common reason cited by manager influencing
their decision to cross list. The US stock market often provides access to lower cost of
capital and greater access to equity capital in the case of high growth technology firms that
require large amounts of venture capital at high valuations to scale (Ferris, et al., 2009).
• Exposure: US stock market listings also provide exposure. Research shows that “prestige
and image’ were also cited by managers as reasons for cross-listing. For firms that export,
there is also evidence that cross listing brings them ‘closer’ to their customers from a sales
and marketing perspective. Firms are more likely to cross list in countries where they have
customers or a significant operational footprint. (O'connor & Phylaktis, 2012)
• Technical: Ferris also points out technical reasons such as merger and acquisition (M&A)
activity. A US target company is more likely to accept equity as a form of payment from a
foreign acquirer if the company is listed on the US stock exchange. (Ferris, et al., 2009)
Simpler routes to acquisition mean faster growth. Therefore, technical reasons may also
influence a company’s decision to cross-list.
But to achieve all or some of these benefits, the benefits of private control have to be given up
and new standards adopted for transparency/corporate governance. For a company focused
on growth and returns, it seems that the role of corporate governance is more of a trade off
than a goal in itself. Without the comfort that improved corporate governance provides to
investors, the above listed benefits such as liquidity, exposure and easier M&A activity will
probably not occur.

129. Arguments against the
benefits of cross listing
• However, this section would be incomplete without examining the arguments against
this. It has been argued that the Securities and Exchange commission (SEC) in
America which regulates the US stock exchange does not treat foreign and domestic
firms that are listed in the same way. Foreign cross listed firms are under less
stringent disclosure rules that their domestic counterparts. Furthermore, there are
very few enforcement actions taken by SEC against foreign companies (Ferris, et al.,
2009).
• But even taking this into consideration, a US cross listing requires a foreign company
to subject itself to two subsets of governance, disclosure and scrutiny. A combination
of both the ‘hard’ bonding of the US legal system with SEC as its regulator there is a
new set of laws and regulation that as company listed on the US stock exchange is
subject to. In addition to this, there is the ‘soft’ type of bonding. There is evidence
that foreign companies that cross list are more likely to engage one of the high
calibre and trusted audit firms to audit their financials. Moreover, the myriad of
investment analysts, underwriters and institutional investors, known as monitoring
intermediaries, provide further scrutiny. These types of agents may not be present
or as active and influential in emerging markets as they are in the US market. (Ferris,
et al., 2009)

130. Corporate Governance case
studies from around the world

131. Instructive for
Africa
Good corporate governance can make
a difference by broadening ownership
and reducing concentration of power
within societies. It bolsters capital
markets and stimulates innovation. It
fosters longer-term foreign direct
investment, reduces volatility and
deters capital flight.
-James Wolfensohn, World Bank
(1998)

132. Key governance features
of Asian firms before the
financial crisis
• Corporations were highly indebted.
• Accounts presented a barely recognisable
picture of companies’ financial status.
• Directors, regulators and courts lacked
training and power
• Controlling shareholders and top
managers were largely unaccountable.
• In many markets, the whole corporate
edifice was riddled with government
interference, corruption and kickbacks.

133. South Korea
• The political and economic power of large conglomerates, known as chaebol, who believed that they had much to lose from any reforms, meant that
governance reform was often of secondary concern. Prior to the financial crisis, South Korea’s chaebol built up excessive amounts of debt – the average
debt-to-equity ratios ranged from 400% to 500% and engaged in massive overinvestment.

134. The big five
In response to the crisis the government ordered the chaebol to follow
five principles (ACGA, 2000) these included:
i. Debt reduction
ii. Restructuring through sale and merger with the aim of
becoming smaller and more efficient
iii. Eliminating ‘mutual payment guarantees among affiliates’, a
practice that had led to the build-up of huge levels of debt with
little incentive to repay
iv. Improving transparency – one area highlighted was the need to
produce consolidated financial statements for the entire group
not just individual subsidiaries, which would give shareholders a
better picture of the financial position of the entire group (why
do you think this information might be useful to investors?)
v. Strengthening the rights of minority shareholders.

135. Singapore
Singapore is typically regarded as having a high standard of corporate governance and
accountability, it also shares many of the characteristics of other Asian economies with weaker
governance practices.
For example , the state run investment company Temasek, controls a large number of domestic
companies, and has been criticised for overly influencing the acquisition strategies of these
companies.

136. Isetan Case
• Isetan is a Japanese company listed in Singapore
• Large concentrated shareholders/ ‘independent’ directors who were also brothers
who has previous business dealings with Isetan
• Received tax credit and didn’t explain to shareholders what they wanted to do
with it. Further issues with large amounts of money in fixed deposit, yet
consistently low dividends. Their real estate company: orchard earnings weren’t
disclosed.
• 43 shareholders, owning almost 10% organized to write a letter to management
demanding an EGM
• Chairman was initially obstructive saying that a ‘fighting stance’ would not help
the case of the minority shareholders. They responded that he should buy them
out if he felt they were not relevant enough to deserve an explanation
• Eventually resulted in a win-win, where an interim dividend was announced, but
because of the increased transparency, share price rose stimulating similar
conversations across other companies that also leveled up their governance.

137. DaimlerChrysler Case
• The merger in 1999 of the US car manufacturer Chrysler and the
German car manufacturer Daimler-Benz.
• Strong business logic underpinning the merger.
• Less clear was the logic in merging two companies with very different
cultures.
• This culture clash was most evident on the board
• the merger would be incorporated under German Law which stipulated
a two-tier board system with half the supervisory board taken up by
employee representatives while Chrysler was almost exclusively
dedicated to shareholder value.
• Daimler’s largest shareholders were German banks who occupied
three board seats, while Chrysler’s board was dominated by outsiders.
Moreover the management style of both companies differed in style.
• Chrysler was chaired by Kirk Kerkorian, who made his fortune investing
in gaming tables in Las Vegas and was focused on the share price, a
focus maintained through calls for buy backs, dividends and takeover
bids, whilst Daimler was chaired by Himar Kopper, also chairman of
Deutsche Bank.

138. Disclosure
• Another potentially fractious issue concerned disclosure - German investor relations practices and accounting standards are
far less transparent than in the US. Sure enough, the company's first annual report caused palpitations in America.
• The annual report (sans proxy statement) contained no details on executive pay, director stock ownership or information on
largest owners. Moreover, the company refused to accept any votes received electronically. And the deadline for receiving
votes by mail was four days before the meeting, not the day of the meeting as is standard in the US. “Some investors will
doubtless claim disenfranchisement,” said international governance commentator Stephen Davis.

139. Pay
• Germany's consensual, egalitarian corporate culture meant
that German executive pay was modest compared to that of
their US counterparts. In the year before the merger, the ten
members of Daimler-Benz's management board earned
about $11 million between them. Jurgen Schrempp himself
took home about $1.5–$2 million of this sum.
• Bob Eaton, in the same year, received salary and bonus of
about $4.6 million, but cashed in share options worth more
than $5 million. Bob Lutz, Chrysler's outgoing vice-president,
did even better, cashing in more than $13 million of share
options.
• In sum, the top five Chrysler managers took home more
than three times what their ten Daimler counterparts made.

140. Efficiency
• Each vehicle took Chrysler around 40 hours to make, compared with 20 or so for the American factories of competitors
such as Honda and Toyota.
• Purchasing was inefficient and fixed costs were far too high for a company of its size.

141. Break up
• The break-up of DaimlerChrysler
was announced in May 2007 with
the sale of 80% of Chrysler to a
private equity firm. Although many
of the reasons cited for the break-up
were market related (e.g. rising oil
prices and lower demand for
Chryslers large vehicles), many
agree that simply adding two
companies together with little
regard for corporate governance
cultures was one of the main
reasons for the failed merger.

142. Conclusion
• Reasons why companies seek international finance
• Cross listing; issues and challenges
• Case studies from Asia
• Case study of a ‘failed’ merger between an America company and a European company

143. Unit 8
Overview of
Corporate
Governance
Codes

144. Content
• Discuss the main international principles
of corporate governance and explain the
reasons for their existence
• outline the complexities involved in
writing international codes of best
practice
• critically evaluate the concept of
shareholder value and explain why it has
been the focus of corporate governance
codes
• evaluate the usefulness of such codes in
practice.

145. Most prominent
• OECD
• ICGN
The principle of shareholder value remains a central focus in almost all codes. But it also
has its drawbacks and new doubts have been raised over the relationship between the
maximisation of shareholder value and sustainable economic growth.

146. References
• Corporate governance by Monks and
Minow
• Soas module reader on corporate
governance